Invest In Real Estate Crowdfunding Or REITs?

One question I often get asked is why should an investor invest in a real estate crowdfunding platform like Rich Uncles or Fundrise instead of directly investing in a Real Estate Investment Trust (REIT)? This is a great question that deserves some full analysis.

By way of background, I’ve invested in physical real estate in Honolulu, San Francisco, and Lake Tahoe since the mid-1990s, REITs since the late-1990s, and now real estate crowdfunding since 2016. I spent 13 years working in the equities department of Goldman Sachs and Credit Suisse, got my MBA from UC Berkeley, and have been writing about real estate investing online since 2009.

A real estate crowdfunding platform gives their investors direct access to real estate investments whereas the idea behind a REIT is that you have exposure to real estate without actually owning, directly, the property.

What is a REIT?

A REIT is essentially a corporation that owns and manages a portfolio of income-producing real estate properties such as apartments, hotels, malls and office buildings (Equity REIT’s or EREITs), mortgages secured by such real estate (Mortgage REITs or MREITs) or a combination of the two (Hybrid REITs).

REIT’s can also be private or public. Private REIT’s are not registered or traded with the Securities and Exchange Commission (SEC) and raise equity from accredited investors (i.e. individuals, trusts or other entities) whereas publicly traded REITs are registered with the SEC and traded in major stock exchanges such as the NYSE, NASDAQ and AMEX.

There are over 800 private REITs and over 200 publicly traded REITs in the United States with total assets of $400 billion. Accordingly, REITs make up only a fraction of the $11-12 Trillion Dollar US Commercial Real Estate Market.

Some of the most popular publicly traded REITs include:

Realty Income Corporation (Ticker: O, 4% dividend yield)

Omega Healthcare Investors (Ticker: OHI, 7.6% dividend yield)

How REITs Compare To Real Estate Crowdfunding

Real Estate Crowdfunding and REITs are similar in a lot of ways. Both options offer investors balance and diversification from the traditional stock and bond markets as well as value from both the current income produced from rents as well as long term appreciation of the underlying real estate asset. Both investment options also permit investors to pool their capital with other investors and thus offer a less capital intensive way to invest in a wider range of real estate.

Finally, as with a Fundrise investment when you invest in a REIT, you do so passively and thus you don’t have to worry about the day-to-day operations and management of the asset which instead is handled by reputable management team.

Important Differences

The main difference between a Fundrise investment and a REIT investment is that with Fundrise you are investing directly into tangible commercial real estate whereas with a REIT you are investing in a corporation that in turn invests your money into real estate.

In fact up to 25% of a REIT’s total investments can be in assets other than real estate. Accordingly, Fundrise offers investors more control and transparency than a REIT since investors have the ability to personally select each pre-vetted investment opportunity.

1) Higher Leverage & Higher Returns: Direct property ownership benefits from the power of leverage (up to 80%) whereas REITs are generally leveraged at or less than 50%. Higher leverage means higher potential returns (because you can buy more property with less equity).

2) Less Volatility: Although touted as an effective way to diversify a stock portfolio, the performance of REIT shares have closely tracked overall equity market performance resulting in correlation coefficients as high as 0.86 (as early as 2011). This means that publicly traded REIT’s are moving in near lockstep with the market at large and are subject to the same volatility. During the same period, the comparable equity market correlation for private real estate has been close to 0.14 (ranging from -0.03 and +0.25; a very low correlation).

3) More Transparency and Control: When you invest directly into a real estate asset, you know exactly what you are getting and thus the process is transparent and you maintain a certain level of control. On the other hand, when you invest in a REIT you are buying into a corporation that owns a pool of properties and you may not know exactly where your investment dollars are going.

Real Estate Crowdfunding Changing Investor Access

Until recently, and because of the typical minimum investment thresholds for most private real estate deals ($250,000+), REITs have been the only viable option for investors wanting to diversify their portfolio by investing in real estate.

If you are not an accredited investor ($200K income or $1M net worth excluding primary residence), not a problem. You can look into Fundrise’s eREIT option. They are like a hybrid of individual real estate crowdfunding investments and private REITs. The fees are a little higher, but you get to access a more focused real estate region in America.

Here are the current three eREIT choices from Fundrise.

Examples of Fundrise’s currently open eREITs

Bullish On Real Estate Crowdfunding

Real estate crowdfunding is going to be a huge opportunity for investors in the coming decade. The technological platform will open up a flood of capital from expensive coastal cities like NYC, SF, LA, and Washington DC, towards inexpensive midland states. Further, the income growth opportunities in the heartland look to have some of the largest upside in the country.

Good investors always think about secular changes, regardless of where they stand on the political spectrum. Thus, I believe heartland real estate should outperform over the next 10 years because:

A Republican president will give back to the people who got him there through the theme, “Hire American, Buy American.”

There will be a net migration out of Blue states into Red states as more people realize it’s a great deal living in Texas if you can get 3X as much for 1/3rd the price.

As our country gets older, more retirees will move out of Blue states to stretch their retirement dollar.

The remote work trend will continue due to technology and a tight labor market.

Sanctuary cities are at risk of seeing their federal funding pulled and reallocated to Red cities.

Income growth should be higher in Red states due to demographic shifts.

Now that investing in real estate is more efficient, Red State 10%+ cap rates compared to <4% cap rates in Blue cities are too hard to ignore. The spread should narrow.

A potential expansion of who can invest in real estate crowdsourcing will lead to an increase in demand and prices.

The rise of real estate crowdsourcing platforms such as Fundrise increases the supply of capital, thereby increasing the demand and prices of previously hard to tap investments.

New tax codes for 2018 and beyond call for a capping of SALT deductions to $10,000 and a limit of new mortgage interest deductions for mortgages up to $750,000. This is bad for expensive coastal city real estate.

About the Author: Sam began investing his own money ever since he opened an online brokerage account in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at two of the leading financial service firms in the world. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $200,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies and writing online to help others achieve financial freedom.

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